Today's IBM bigger, Broader, Better

3/9/2009


 

  Recent Price
$88
  Dividend
$2.00
  Yield

2.3%

  P/E Ratio
10
  Shares (millions)
1,348
  Long-Term Debt as % of Capital
40%
  52-Week Price Range
$130.93 - $69.50

When traditional revenue streams slow to a trickle, IBM ($88; IBM) has a knack for finding and tapping new springs. In recent years IBM shifted away from computer hardware and toward less-cyclical markets, such as systems, services, and software. That broad business mix has helped IBM maintain profit growth, supporting the share price. Up 4% for the year versus the S&P 500’s 23% slide, IBM has rallied 26% from November lows.

Per-share profits surged 24% in 2008 to $8.93 per share, topping the consensus by $0.25 in the December quarter. IBM says it expects per-share profits of $9.20 this year and $10 to $11 in 2010, well above the consensus estimates of $9.05 this year and $9.86 next year. IBM is a Focus List Buy and a Long-Term Buy.

Balanced business mix
Demand for computer hardware (19% of 2008 sales) lost steam late last year and will likely weaken further in early 2009. Hardware revenue declined 16% at constant currency in the December quarter.

With hardware facing competitive and economic pressure, IBM must rely more heavily on the software and services segments. Software revenue (21% of sales) rose 8% in 2008 at constant currency. IBM’s services units (57% of sales) managed 6% sales growth at constant currency last year, signing up $17.2 billion in new business in the December quarter.

Outsourcing orders reached $7.4 billion for the quarter, up 20%. While services demand remains solid overall, outsourcing has been particularly strong as clients scramble to cut costs.

Excellent outlook
This year, IBM expects profits to rise 3%. The profit target, $0.15 higher than the consensus, seems conservative given IBM’s recent operating momentum. Cost cuts and share buybacks should account for all of the expected growth, and any improvement in the business climate could drive earnings higher. In February, IBM said it expects long-term contract signings to rise at a double-digit rate in the March quarter.

Excellent free cash flow, up 24% to $11.7 billion in 2008, gives IBM flexibility to pursue stock buybacks and make services and software acquisitions. The company spent more than $38 billion on stock buybacks in the last four years, reducing the share count by 21% during that period. Similarly aggressive buybacks appear likely in coming years.

IBM also stands to benefit from federal stimulus funds through its investment in “smart grids.” The U.S. Department of Energy plans to allocate $4.3 billion for smart grid projects in the next two months as part of $11 billion reserved to modernize the electric grid.

Conclusion
IBM earns a Quadrix® Overall score of 88. The shares trade at less than 10 times the 2009 consensus profit estimate, well below the five-year average forward P/E ratio of 15. IBM has raised its dividend in each of the last 13 years, and the quarterly payout has jumped 150% over the last three years. Given that dividend history and a strong balance sheet, another increase is likely this spring. An annual report for International Business Machines Corp. is available at 1 New Orchard Road, Armonk, NY 10504; (914) 499-1900; www.ibm.com.


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